Mortgage affordability

How lenders decide

Affordability is not calculated from the house. It is calculated from your income, and everything else follows. The chain runs in one direction:

1. Take your gross monthly income.
2. Multiply by the debt-to-income limit to get the total the lender will let you commit.
3. Subtract your existing debt payments and the running costs of the property.
4. What remains is the mortgage payment you can support.
5. Convert that payment into a loan amount at the current rate and term.
6. Add your down payment to reach the purchase price.

The last step uses the annuity formula solved for principal rather than for payment:

loan = payment × (1 − (1 + r)^−n) / r

Every input above the last step changes your budget. Only the rate and term change how much loan that budget buys.

What the income actually buys

Every figure below comes from the calculator above, holding the rate at 6.5% over 30 years with $400 of other debt, $350 of monthly property costs, a 36% limit and $40,000 down.

The relationship is close to linear once the fixed deductions are covered, which is why the “three times income” rules of thumb roughly work and then fail at the edges: the debt payments and running costs come off the top, so they eat a much larger share of a modest income than of a large one.

Starting from a monthly payment instead

Many people come at the question from the other end: not “what does my income support” but “I can afford $1,200 a month, so how much can I borrow?” That is a simpler calculation, because it skips the lender's ratio entirely. A fixed payment, a rate and a term determine the loan exactly. The table below gives that loan for common budgets on a 30-year fixed mortgage at three rates.

Before reading across, settle what your monthly figure includes. A loan payment covers only principal and interest, while the number you budget for usually also carries property tax, homeowners insurance and any association dues. Subtract those first. At $350 a month, a $1,200 housing budget leaves $850 for the loan, which at 6.5% supports about $134,000 rather than $190,000 — a difference larger than most down payments.

To run your own numbers in the calculator above, enter your monthly property costs in their own field. The result then shows the monthly payment next to the maximum loan, so you can check that payment against the figure you had in mind; if it is higher, lower the debt-to-income limit until the two agree.

The number lenders watch

Debt-to-income is the ratio that decides most applications. It compares everything you are contractually obliged to pay each month — the new mortgage, plus car finance, card minimums and student loans — against your gross monthly income.

Note what this implies: paying off a car loan can raise your mortgage ceiling by considerably more than the loan balance itself. Removing a 400-a-month payment frees 400 of monthly budget, which at typical rates supports roughly 60,000–65,000 of extra borrowing.

What a rate change is worth

Same income of $90,000, same everything else. Only the rate moves.

Two points of rate takes out roughly a fifth of your borrowing power. Nothing about your finances changed; the same salary simply buys less house. It also runs the other way, which is the part worth remembering in a falling-rate market: your budget stretches further, and so does everyone else's, which is why prices tend to absorb some of the gain.

What your other debts cost you

Existing payments come straight off the monthly budget, and the budget is what gets converted into a loan. The last column is the mortgage those payments are costing you.

Each dollar of monthly payment costs roughly 158 dollars of mortgage at these terms. A car loan with $8,000 left on it and $400 a month to run is removing around $63,000 of buying power — clearing it can do more for your application than putting the same money into the deposit.

Why the rate scenarios are there

The three bars below the result show the same budget at today's rate and at one and two points higher. Most buyers are surprised by how much ground they lose. It is worth looking at even if you are taking a fixed rate, because it tells you what the market will look like when you come to remortgage, and what the property might be worth to the next buyer if rates have moved.

Costs this calculation does not carry

The monthly property costs field covers ongoing expenses, but buying a home also has one-off costs that come out of your deposit, not your monthly budget: legal fees, survey, transfer taxes, and moving. Depending on the country these run from 2% to 10% of the purchase price. If you enter your entire savings as the down payment, the price shown here is too high by whatever those costs turn out to be.

Maintenance is the other quiet one. A common planning figure is 1% of the property value a year, which does not arrive as a monthly bill but does arrive.

The gap between approved and sensible

A lender is underwriting the loan, not your life. Their model does not know that you want to change careers, that one income might pause, or that you would like to keep saving. The maximum figure is a ceiling, and treating a ceiling as a target is how households end up house-rich and cash-poor.

A useful discipline: find your maximum here, then set the debt-to-income slider to 28% and look at that number instead. The difference between the two is the margin you are choosing to spend or keep.